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Introduction
The main goal of this paper is to analyse the two market exit approaches initial public offering (IPO) and mergers and acquisitions (M&A). The theoretical analysis is done along with the detailed comparison of two approaches. The choice of a firm between going public (IPO) or be acquired (M&A) depends on many underlying factors. This theoretical analysis ca play a significant role is very significant in findings of emerging financial literature on IPOs and M&As. The main focus of study is on venture capitalists backed businesses decisions of acquisitions and going to public. The practical examples of technological companies exit decisions through IPO and M&A are discussed in detail to evaluate the potential and suitability of both approaches.
Venture capitalists whose main job is to make capital investment in companies owned by individuals not governed by any public authorities create their maximum income from companies that are open to people or registered with the stock exchange. A Venture Economics (1988) survey proves that “a $1 investment made in companies that gets registered with the stock exchange gives a normal profit of $1.95 more than the amount of primary investment if normally invested for a period of 4.2 years. The second most excellent option is an investment made in a purchased organization which gives a profit of simply 40 cents for the investments for a period of 3.7 years” (Gompers & Lerner, 23). Whereas study proposes that an IPO is more beneficial outlet plan for venture capitalists, it has been observed that in some organization, venture capitalist preferred an M&A above an IPO. In order to clarify this extraordinary event we will have to investigate the skill of the management functioning which influenced this choice of the venture-backed organization.
Financers, while financing in a new firm has to go through a lot of risks but doubt considerably increases as soon as the company starts functioning in technology-intensive organization. In such organizations, financiers and predictor or forward planner do not have technical information whereas the present possessor or proprietors of the company have full and widespread knowledge concerning not merely the in-house process of the industry but also have broad awareness not simply of the in-house practice of the industry but also its modernization capability.
The organization which is classified by specialized information, although if the financiers have full knowledge concerning the organization they might be incapable of understanding such particulars or details. In a different way we can say, although the proprietors are forced to make available precise and full details of the company’s functions, the financiers might not have the ability to construe these data if it needs to have the knowledge of the company’s professional abilities (Capron, 104).
Theoretical Background
In the last twenty years the researchers of management and finance have arrived to an immense perception with regard to the function of venture capitalists in the formation of new organizations, the formation and control of venture investment firms, and basically on the whole venture investment phase as an observable fact, from beginning to end (Gompers and Lerner, 99). In the collective information about venture investment, researchers and intellectuals have recognized how venture investors and their firms vigorously take part in the lapses of private organizations on account of board of director’s perceptions (Lerner, 299), the performance of the combination of venture resources in investment surroundings , the formation of positive governing privileges, and regular VC-CEO communication. All of these methods have been created as an outcome of possible organizational dilemma, such as ethical risk and poor choice, due to proportioned knowledge in the market vicinity the kind of organizations looking for venture investment, frequently on initial phase, innovation-based or technology-driven firms.
An initial public offering or IPO, is a commercial act in accordance with which a company offers initially its normal shares to the people with the motive of getting investment and generate liquidity for its present shareholders (Ritter and Welch, 1799), as well as venture investors, who helped the firm during its expansion and progress. Venture investors are mostly important financier having strong equity status, who vigorously manipulates the IPO procedure by organizing the company to make perfect use of their open capital investment as well as help them to decide when they should make access in the market.
Market situations are vital for deciding that the company must go for an IPO or take a substitute, look for amalgamation or purchase of a recognized company. For a biotechnology, Lerner (299) established that in a test of 350 private venture-backed biotechnology organizations, experienced venture investors show by and large of being an expert in taking the public companies close to the market heights. He established that in 1978 and 1992 venture investors took their biotech firms to the public markets (IPO) when the price were at peak and engaged additional private equity investments instead of when prices were lower (Lerner, 04). Hence, from previous text we can say that it becomes obvious that not only venture investors has a dynamic part in the commencement and enhancement of an immature company, but also in the way out plan for financiers and the management of these organizations.
Mergers & Acquisitions
A well known business forms a strategy to inquire amalgamation or combination for project industrialists. In order to Boost rating in organizations, companies have new technical advancement which may be eye catching as they are the key factor of developed organizations. This decision lets organization an opportunity to get many benefits like uncertainties in organizational decisions are avoided and innovation is encouraged.
In huge organizations merger and acquisition is perceived as a productive option in initial public offering in technological based companies. As these industries encourage technological moves and rise due to their sequential processes in development. Small organizations after going to public are opted for mergers or acquisition in order to capitalize the market offerings. This strategy is followed by technology intensive companies more rigorously to materialize their technological edge for large corporations.
Technology Diversification, Cumulativeness and the M&A Decision
This piece of work examines the industrialist believing on innovation and technology and the impacts of merger and acquisition decisions. The already established studies indicate that companies who regard technological advancements differ with those who disregard it with respect to the competences in their research and development department. Technology has significant impacts on the inception of a novel organization in general terms and in calculative terms.
The industries in industrial paradigm differ with each other on theoretical and empirical grounds. Whenever resolving an issue or offering new dynamics are thought about, the technology assists as it provides dimensions that are applied on people and organization as a whole to meet their needs and to facilitate processes in a better way. The enhancement in technology has no limits and the industries that have potential to adopt novel technology are ahead in the line by leaving other industries behind. By viewing and considering previous experiences, the company regards for present and future activities using their technological knowledge and participation in this regard.
The variations existing in industries as regards the circumstances narrated earlier have been linked to industry density. Marleba and Orsenigo (293) contend that industries which offer elevated number of technological opportunities would exhibit higher industry concentration. The greater number of technological opportunities would permit an uninterrupted access to new entrants but the recognized businesses would most probably advance their comparable innovativeness, which would ensure that the less profitable rivals are removed from the business arena. The reputable businesses have an edge due to the store of information and skill sets they have already acquired, especially in an environment of greater scientific cumulativeness. Therefore, in such an atmosphere, new players will not enter the field.
There is a general contention that the variations existing amid industries impact whether business enterprise capitalists leave their technology-intensive venture-backed firms by taking them public (IPO) or by selling the business. More to the point, we advocate that the level of technological diversification and technological cumulativeness in a particular field would impact this decision. Due to the whole environment of high technological diversification and high technological cumulativeness would result in greater density, mergers and acquisitions would be the preferred mode more often than IPO. In other words, technological diversification and cumulativeness would possibly bring about an increased level of industry consolidation which would hint at and facilitate a greater number of M&As.
Firm Age and the M&A Decision
Earlier studies have established the fact that businesses are consistently good at pursuing certain skill sets and competitive Merits. They also prefer to adhere to certain technological trajectories as compared to other because scarce resources and bounded rationality. Certain businesses also outsource information and data services in order to stay ahead in the race of innovation and the increased diversification required in order remaining at the top of the game. Taking help from another firm’s skill sets and data repositories can strengthen a company in ways which working independently may not facilitate. It follows that new firms, while mostly focusing on combing knowledge within their limits, can increase their profitability and likelihood of survival by searching for needed competencies in the external environment.
It would also be logical to think that as firms are established and mature, the chances of its survival are improved because inside their own boundaries, they have achieved the maximum possible competencies and need to look outside so as to stay ahead. This possibility may also decrease after a certain span because maturity would mean lesser chances of M&As. If the decision to leave the arena is put off, it may communicate to the market that the business is not a viable option. It would become very tough to find a profitable enough bid to be able to leave the industry and the seller may have to wait till the public is more receptive to IPOs.
Signaling and the M&A Decision
The fact that the intensity of rivalry in technological industries is high, coupled with the fact that nothing in R&D is cut and dried, makes investment in new entrants more risky. This is exacerbated by the problem of the shorter life spans of such enterprises and the long wait before they become profitable as a result of initial R&D. However, investors may base their decisions to invest in such firms by focusing on their potential, in spite of all the certainty and risks associated with backing a business which may or may not yield returns (Nerkar & Paruchuri, 25). One reason for such decisions may be the perceived strength of such businesses. The investors may have to evaluate the clearly apparent qualities of the continuous innovation and growth possibility of such enterprises because the quality of such firms may not be apparent in tangible ways. These positive proofs may include the reputable and creditable profiles of the VCs which are investing in these firms, along with the total leverage that the firm already has. Stated in other words:
This amount, along with the profiles of the investors and the credibility that they have in the market are seen as proofs that such firms are viewed to be viable options and would yield good returns. In other words, holding everything else constant, we think that a greater amount of financial leverage would be related to a better chance of an IPO as compared to an M&A due to the fact that the market would view the firm as a good prospect because of the amount and investment it has already attracted. Also, a new entrant which already has an impressive history of sales has a greater chance of inspiring investors’ trust. In other words:
At the end of the day, a bigger VC business has a bigger profile, with a more expansive business. Specifically, researchers have established that a greater number of business contacts are needed for entering new markets and starting new technology firms and that such inter-business and industry contacts impact the firm’s ability to attract more resources for expansion and growth. Even more so, the investment cycle itself is dependent upon established and time honored contacts among the various players of the field, which bring about industrial and geographical trends and ties of investment which are formed through partnerships and investment networks (Sorenson and Stuart, 1555). Therefore, it is logical to reason that the bigger a VC firm’s network is, the more possibility that it would be in a position to find a good M&A business, especially in an arena which relies heavily on close ties.
Merits and Demerits of IPO and M&A
Every organization desires for a top position in market. Initial public offering (IPO) is associated with good position and good luck. The approach to success with respect to Initial Public Offering has been intimately described in professional writings and social network pages. Companies are striving in their way to competing world and innovative minds are taking the lead.
On the other hand, privately owned organizations consider that asking general people for business related decisions is not the good choice. On the other hand, an acquisition decision or merger and sale may be the suitable resolving point to fulfill the organizational requirements and to offer end term consequences to the top management.
Initial Public Offering (IPOs)
Merits
- Convenience in forecasted money supply for future growth and expansions
- Developing organizational perspectives as a public entity with broader management vision
- Steps in share factors provide convenience in business decisions
- Forecasted merger and sale options after going to public
Demerits
- Based on the fulfillment of demands of management and market investors
- Not in the range of costs as additional costs are incurred during IPO processing
- Disturbances in daily transactions due to auditing and other legal requirements for IPO
- Adequate leakage of data when required due to public access to undisclosed data.
- Small duration based activity can be affected by change in economic or political environment
- Internal management’s stock factors affected on the market stock prices
- Stocks pertaining to market place are subject to change according to trend of market
For an illustration, if any option like this is available, it may lead to number of pros. Initial public offering is subject to forecasted money arrangement decision faster, swift, convenient and cheaper. The organizational portfolio is developed and enhanced vision is offered to investors, clients and intermediaries. Other plans stock related programs offer amazing Merits to customers. In short, the initial public offerings are subject to enhancing the future based merger and sales plans.
Issuing shares in general public for the first time may bring adequate cost related issues. For example, it is one of the time and efforts taking process. The costs in terms of outer cost management should be regarded carefully disturbing this process and transactions of organizations on a long duration as many employees will be assigned special tasks. On the other hand, when the organization goes public it has to commence and follow the rules and regulations of security federal laws. Back in time, the implicit data pertaining to employee’s compensation were supposed to be known. Associated with that, the decision for going public, the management was focused on short-term durational activities and the main concern was the organizational move on quarterly assessment instead of five-year durational plan. Another concern was about the investors view point on quick development of investments. The shareholder’s options needed definite time as viewed by underwrites and needed ‘lock-up’ process with minimum time range three months and the maximum extended to several years. An offer was made regarding the internal management’s decision to stock factors. Last but not the least; an organizational decision revolves around the market place moves. Our evaluation may be underlined based on number of opinions; some are mutually exclusive to company moves. For example, any up or down in environment by large or the company trends in a market.
Mergers and Acquisitions
Tracing back in times, some past years have observed an increasing trend of mergers and acquisitions in private companies similarly like public companies. The phenomenon is dependent on merger and acquisitions activities based on an exit plan associated with management and considerable improvement chances for organization.
There are many pros of the exit strategy when we view it in broad terms. Firstly, you may enjoy quicker development, as this involves low time duration than the general process of asking public for buying shares. It also does not restrict the owner to be confined to ‘lock up’ conformity to compel him to keep stock for long duration. Secondly, company wind up is certain to a large extent before the prices go down; owners have an opportunity to sell out the company. The agreement also includes the terms of purchasing based on cash with no provisions related with ‘earn out’. Considerations are already set up in a seasonal based organization when pricing matters are discussed. Thirdly, initial public offering information leak out does not allow acquisition and merger related options to disclose information. In conclusion, winding up business involves a choice given to top management owe companies on contrary of asking general public. Even though, the organization has irregular and unreliable outcomes, there yet are chances of finding a buyer or you may go to a bank to ascertain underwriting matter.
Merits
- Quicker strategies related with exit plans can be executed in less time with available resources
- Pricing strategies are accounted for low costs and maximum benefits in less time
- Removing barriers in disclosing certain information as the information is limited to the management of acquiring company
- Merits achieved as a result of merger with huge organizations to share the established brand equity and market share.
- The advantage of synergies as various sister concerns can support each others business.
The performance of an organization rises when it is associated with acquisition and merger activities. It is hectic for lots of smaller organizations to maintain their positions in a marketplace as consumers are prone to dynamic variation in their choices. Consequently, numbers of small companies sell to large companies and they develop potentials to deal with negotiation in large organizational set up. The top decision makers of a company as well go into the decision of taking Merits from synergies broadly with strong companies. Earnings and expenses are the focal point in this decision making. The earnings may result from operations of a company that involves advertisement and promotion in an effective way, a strong allocation of association and a balanced product mixing decision. It may also be subject to Merits the selling party with regard to product or offering valuable services. Besides that, economical scale is assisted in connection with huge organizations, innovative minds arrive and technologic advancements are shared. The public companies are inclined toward merging with other successful companies to get the hold.
Recent observed Trends
The proportion of acquisitions and mergers in private firms has been considerably increased in last few years. In last decade, private firms have been opted to be acquired rather than going to public. The ratio of acquisitions to IPOs among private firm exits has increased. National Venture Capital Association (NVCA) reported in its research that venture capital based companies exit through M&A more than that through IPO. In 2005 alone, acquisitions amounted to 78% of the total venture capital firms exit. Also in 2006 and 2007, the volume of 269 acquired firms worth 11.890 billion as compared to the 37 venture supported IPOs value of $3.486 billion.
The financial crunch and severe crisis of 2008–09 temporarily decreased the ratio of M&A in USA and other European countries, but this decline has increased the future opportunities for acquisitions. Since companies started restructure and consolidate at high speed after recession due to the company strategic move or government pressure. Companies with excess cash in recession took advantage of acquiring companies with financial incapacities. For instance, in pharmaceutical sector alone in 2009, Roche forwarded bid of US$40 billion to Genentech, Wyeth was offered $68 billion by Pfizer, and Schering-Plough recovered offer of $41 billion from Merck.
Tech Companies IPO vs. M&A Analysis
In case of technology companies, the decision of going to public needs proper thinking and appropriate strategies. Since the trend for small and big venture backed firms is gaining more benefit through mergers and acquisitions. During the phase of recapitalization, an IPO is event of financing which cannot be treated as a means of liquidity. For the supporter of this strategy, it is remarkable that in information technology sector, 112 IPOs have offered globally in 2010 as compared to 79 in 2009, but this fact does not prove that best exit strategy is IPO. In reality, the picture of IO is not very fascinating as approximately 80% of these IPOs are trading below offer value at present in US and Canada. Some of the examples of this worst trading is of QuinStreet at 33% less than that of IPO offer value, TeleNav at 37%less, Convio at 9% less, and Meru Networks at 24% less thanthat of IPO value in US stock exchanges. Only few IPOs have seen bearish trend after exit decision of the company.
Therefore, it can be said that one size cannot fits everybody as every company and industrial sector has specific considerations when going to decide for exit. In some cases, it is before time that a new company goes for IPO therefore for small size and age Macon is a good option. In order to see the private equity availability for technology companies, the M&A volumes and deals for other industries also need to be analysed. Therefore, the comparison of recent IPOs performance or lapses is essential to understand the conditions of market. This background knowledge is useful for the shareholder of new public owned companies which can see better opportunities in post IPO acquisitions in near future.
According to the statistics of NVCA, in 2010, 310 companies undergo M&A agreements mostly involved a purchase of small private owned company by a large public acquirer or private capital company in Canada and USA. This shows the highest M&A run rate in one decade which includes the maximum deals in software and information technology businesses, digital media houses, and hi-tech services sector. The average worth of these private owned technology companies M&A deals is comes to about $37.5 million.
Conclusion
In conclusion, An IPO option needs to be used by the company only if it has observed a consistent growth in sales for many ears and have established a firm position in respective industry. Therefore, the choice between IPO and acquisition is made on the basis revenue, size, market conditions, diversification, and strategic policies of the companies. It is recommended that those companies which achieved the excess revenue of $100 million at the minimum and have highly experienced and skilled management team. The management of the company should have expertise of running a public limited company in present scenario of public markets. These companies are capable of attracting proficient underwriters and security analysts who can estimate and promote the stock of company in stock exchanges by using recapitalization methods.
Due to the cyclical nature of IPO markets, the options are not found open for majority companies when they want to do it. The cost of going public is also very high as compared to M&A, includes insurance, audit expenses, compensations arrangements, legal, and governance. These costs force companies to think properly before going to public offerings. The range of these costs varies in the range of $1.5 million to $3 million per annum approximately. Therefore, M&A is more simple and cost effective strategy for companies where management and investors seek liquidity and profitability in short run.
Although, M&A strategy has faced a two year low in financial crisis of 2008-9, now the buy out activities and conditions are remarkably improved for small profitable tech companies in USA. Companies need technology resources and effective human resources as they come out of the severe recession. Acquiring a tech company is one of the most viable solutions in 2010. Accumulation of cash in public limited companies provide s the opportunities for expansions and strategic alliances.
Finally, each firm has to be analysed on its resources, strengths and available opportunities. For technology sector, above analysis shows tat M&A is a more viable option than IPO or going to public. The size and volume of recent deals prove the importance of strategic planning, market opportunities, and management styles of companies. Private owned companies should take benefit of the competition among the groups of strategic acquirers and venture capitalists in the business. The target of the company is to increase the equity of shareholder and brand equity of the firm in the long run whether it can be achieved through IPO or M&A.
References
Capron, Laurence. The Long-Term Performance of Horizontal Acquisitions. Strategic Management Journal, Vol. 20 (1999): 987-1018. Web.
Gompers, Peter., & Lerner John. The Venture Capital Cycle. Cambridge, MA: MIT Press. (1999).
Lerner, John, Venture Capitalists and the Decision to Go Public.” Journal of Financial Economics, 35: 293-316, (1999), print.
Malerba, Frank. & Orsenigo. Larson. Knowledge, Innovative Activities, and Industrial Evolution. Industrial and Corporate Change, 9(2): 289-314, (2000), print.
Nerkar, Albert., & Paruchuri, Sam. “Evolution of R&D Capabilities: The Role of Knowledge Networks within a Firm.” Management Science. 51(5): 771-785. (2005). Print.
Ritter, Jason and Welch, Ian. A Review of IPO Activity, Pricing, and Allocations.” The Journal of Finance, LVII(4); 1795-1828. (2007). Print.
Sorenson, Oliver. and Stuart, Mendel. Syndication Networks and the Spatial Distribution of Venture Capital Investments. American Journal of Sociology, 106(6): 1546-1588. (2001). Print.
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